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Research paper example essay prompt: Zero Inflation - 1993 words

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Zero Inflation Introduction Hyper inflation has plagued most of the worlds developing countries over the past decades. Countries in the industrialised world, too, have at times duelled with dangerously high inflation rates in the post WWII era. With varying degrees of success, all have employed great efforts to bring their inflation rates within acceptable limits. Generally, a moderate rate of inflation has been the ultimate goal. More recently, however, a few countries have pursued policies that strive to eradicate inflation altogether through complete price stability. This has proven to be a contentious enterprise, which clearly indicates that there is still no universally accepted solution to the inflation problem.

Indeed, there is not even an agreed consensus regarding the source of inflation itself. The monetarist perception that the root of inflation is solely the excessive creation of money remains. So too does the belief that inflation originates in the labour market. And amongst a variety of others, the opinion that inflation serves the critical social purpose of resolving incompatible demands by different groups is also strong. This last, and more widely accepted, case shows that the problem is hardly a technical one; but rather a political one.

It highlights the now unquestionable fact that politics and inflation are inextricably linked. And as with all inherently political issues, consensus is difficult, if not impossible, to achieve. But, political characteristics do provide flexibility. In some countries, high rates of inflation have clearly been compatible with rapid economic growth and fast rising standards of living. In such cases, it is quite reasonable to suggest that higher rates of inflation are acceptable--perhaps even necessary.

In this setting, it is by no means clear that pursing a policy to stop moderate inflation is either required, or in the best interests of the mass of the population at all. While inflation guarantees that some will gain at the expense of others, the redistributions of income and wealth which do take place can, on normal value grounds, be quite desirable. In other circumstances, it may be quite desirable to place strict controls on inflation, or strive to keep it at zero level. Policies aimed at virtual price stability have been in use by central banks in Europe, New Zealand, and Canada over the past few years. Such policies have been particularly focused in Canada.

As noted by Pierre Fortin, the only objective the Bank of Canada has pursued since 1989 has been to establish and maintain the inflation rate at zero level, which it sees as a CPI inflation rate that is clearly below two percent (italic added). To the surprise of many, it has been incredibly successful, achieving its objective several years before schedule. Although separated by only a few percentage points, Canadas policy is a sharp contrast to the moderate and balanced approach used in the U.S. Since 1989 the Federal Reserve has been satisfied with achieving an inflation rate of around 3 percent. In setting the interest rate, it has continued to pay explicit attention to real economic growth and employment, with the result that the U.S.

unemployment rate is currently in the 5 to 6 percent range. Based on this statistic alone, it can be argued that the more moderate U.S. approach has enjoyed greater success than the deflation oriented policy pursued by the Bank of Canada: Canada continues to be burdened with a higher rate of unemployment. Yet, it continues to believe that the unemployment costs of low inflation are transitory and small . The directors of most European Central Banks also continue to support this dogma. Clearly, the credibility of the classical idea that the Phillips trade off between inflation and unemployment disappears in the long run is still very high throughout the world.

But, in Canada, as in most of Europe, the waiting continues. This is not to suggest that the waiting game has been silent and entirely pleasant. Indeed, the relative lack (or lag!) of success of zero inflation policies and strict price controls has spurred much heated debate. As a case in point, more people are curious why Canada has exclusively focused on inflation cutting and turned a blind eye to the more balanced, and arguably more successful, approach adopted by the U.S. Is it actually desirable, or wise, to aim towards virtual price stability? Are there real long-term benefits to low, or zero, inflation? What are the real effects of low inflation? The intensity of the ongoing debate on these issues provides evidence that there are no straightforward answers.

The purpose of this paper is to probe at these issues in an attempt to cast some clarity on the debate. Appropriately, it begins with an analysis of the consequences of low inflation on the conduct of monetary policy. As is well known, these effects are controversial, and this paper in no way purports to end the deadlock. Bringing the relevant issues to the fore, however, is equal to carrying a well-stocked toolbox that contains many of the necessities for well-crafted opinions. The Consequences of Low Inflation on Monetary Policy In recent years, monetary policy has been promoted to the centre stage of economic policy making the world over.

This is a contrast to the first half of the 20th century when it was relegated solely to experimentation in the shadows. During these early years, fiscal policy was solely used; due in part to the depression of the thirties, and the remainder, to the process of post WWII reconstruction and the Keynesian doctrine that fiscal action was necessary to prevent deficiency in aggregate demand. By the late sixties and early seventies however, most of the developed world was witnessing the emergence of a combination of high inflation and low growth; i.e., stagnation, and the revered Keynesian analysis was unable to devise plausible responses to the phenomenon. Consequently, monetary policy emerged as an eminent instrument of economic policy, particularly in the fight against inflation. Issues related to the conduct of monetary policy worked their way to the forefront of policy debates during the 1980s as growth and price stability were the intermediate and long term objectives. Gradually, a loose consensus emerged among industrially advanced countries that the dominant objective of monetary policy should be price stability, and from the outset of the 1990s, this belief has increased in popularity. However, differences continue to exist among central banks with regard to the appropriate intermediate target.

While some consider monetary aggregates and, therefore, monetary targeting as operationally meaningful, others focus exclusively on interest rates-even though the inter-relationship between the two targets is well recognised. Again, as with all inflation-related issues, there seems to be little consensus. Though it will only be noted in passing here, monetary policy has also gone through a renaissance in developing economies. Much of the early literature on development economics focused on real factors such as savings, investment, and technology as the main springs of growth. Very little attention was paid to the financial system as a contributory factor.

Indeed, through the years countless opinions have highlighted that inflation is endemic in the process of economic growth and is accordingly treated more as a consequence of structural imbalance than as a monetary phenomenon. However, with a growing body of overwhelming evidence, it has become clear that any process of economic growth where monetary expansion is disregarded also leads to inflationary pressures with resultant impacts on economic growth. Thus, price stability and monetary policy have assumed increased importance all over the world, in developing and developed economies alike. Yet, the widespread use of monetary policy to control inflation does not necessarily muffle the roars of policy debate. In fact, the extent to which price stability should be deemed to be the over-riding objective of monetary policy has become an increasingly heated topic of discussion.

The crucial question seems to be whether the pursuit of low inflation; (i.e., price stability) through monetary policy undermines the ability of an economy to attain and sustain higher growth. A substantial body of research occupies the examination of this trade-off, whose roots trace back to the Phillips curve (1958) which demonstrated the inverse relationship between the change in wage rates and unemployment rates. It was here that the suggestion of a trade-off between inflation and unemployment was first laid. Although the Phillips relationship has subsequently been challenged on theoretical and empirical grounds, it continues to form an important locus of analysis and it is prudent to look at in some detail below. The Phillips Curve It is well known, and generally accepted, that the downward slope of the Phillips curve arises basically because of the presence of money illusion and expected inflation deviating from actual inflation.

Based on this knowledge, and its subsequent critiques, the prevailing inflation/monetary policy controversy centres on the possible short-run and long run trade-off between inflation and unemployment. This distinction primarily stems from the assumption of error-learning process in the determination of inflationary expectations - workers do have an anticipation on the inflation, but because they judge the inflation performance from the past data, the adjustment between the expected and actual inflation is slow. This implies that in the short-run, nominal wage rise will not fully absorb the actual inflation, and as such, there is scope for reducing unemployment through inflation. As people adjust their expectations of inflation, the short-run Phillips curve shifts upward and unemployment rate returns towards its natural level. As the expected inflation catches up with actual inflation, the Phillips curve becomes vertical, denying thereby a trade-off between inflation and unemployment in the long run.

Seen in this light, the short term Phillips curve provides a trade-off between inflation and unemployment when an economy is adjusting to shocks in aggregate demand when expected inflation is lower than actual inflation. In the long run, the Phillips curve becomes almost vertical at the (controversial) natural rate of unemployment. Though not discussed in this paper, the plausibility of this natural rate of unemployment has been cast into doubt in recent years. For the moment, notwithstanding the critique of the natural unemployment rate, the Phillips curve presents the possibility of lengthening the short-run trade-offs indefinitely, since inflation surprises in each period can elongate the long-run perpetually. But, in that case the trade-offs will become sharper in each successive period. In other words, to maintain the unemployment below the natural rate, policy authorities will have to inflate the economy at higher rates in each successive period.

This has a major policy implication even if the economy does not operate on the long-run vertical Phillips curve. Under the rational expectations hypothesis, as there are no deviations between actual, and expected inflation, both in the short-run and long-run, Phillips curves are treated as being vertical with no trade-off between inflation and unemployment. Another policy related question is the shape of the short-run Phillips curve itself. In reality, wages and prices are sticky as employment contracts are fairly long and there is also a cost in changing the individual prices too often, or re-negotiating wages after each price rise. It has been argued that the nature of stickiness in wages and prices could be different in different economies, and this could also be a function of the inflation history of the country concerned. If so, countries with high inflation rates would find themselves steeper on short-run Phillips curve than low inflation countries, which are more likely to be on the flatter side.

For the purpose of this paper, what is important, therefore, is that the trade-off between price stability and employment is sharper for countries with relatively high inflation rates, and lower for those with low inflation rates. Price Stability as the objective of Monetary Policy Price stability as the objective of monetary policy rests on the notion that volatility in prices creates uncertainty in decision making. Rising prices affect savings adversely while making speculative investments more attractive. Thus, the most important contribution of the financial system to an economy is its ability to increase savings and allocate.

Related: high inflation, inflation, inflation rate, more successful, first half

Research paper topics, free essay prompts, sample research papers on Zero Inflation